After a year-long fight with the IRS on turning over customer data, Coinbase both won and lost. It won in that the court significantly narrowed the type of information that it was ordered to turn over to the IRS. It lost in that it was still required to turn over data on approximately 13,000 customers. For the 13,000 customers this means that the IRS may now be contacting you to let you know that you may owe additional tax.
The case began on November 17, 2016, when the Department of Justice filed an action seeking an order to serve an IRS John Doe summons on Coinbase, one of the world’s largest digital asset exchange companies. A John Doe summons is used when the IRS doesn’t know the identity of person about whom the IRS seeks information. Here, the IRS was concerned that the roughly 800 tax forms reporting taxable cryptocurrency transactions (as defined in IRS Notice 2014-21) grossly understated the actual number of transactions.
The John Doe summons sought broad information on all U.S. customers conducting transactions in cryptocurrency from 2013-2015, including information about the identity, transactions, and tax liability of customers, as well as any other persons associated with the account, such as beneficial owners. For example, the summons sought all account records, including identity of the customer and its user profile and security settings, know-your-customer due diligence records and anti-money-laundering (AML) exception reports, powers of attorney or other records granting third-party access to a customer account, transaction logs and identities of counterparties, periodic statements and invoices, correspondence and records of payments between Coinbase and its customers.
The IRS later narrowed the scope of its summons to transactions of at least $20,000, and it scaled back somewhat the scope of data it was seeking. The district court for the Northern District of California held that the IRS had a legitimate investigatory purpose to determine if taxpayers were correctly reporting their tax liabilities with respect to cryptocurrency transactions, but that not all the documents requested were necessary to achieve that purpose. The court ordered Coinbase to turn over the following information:
- Taxpayer ID number
- Records of account activity including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties
- Periodic statements of account or invoices
Coinbase informed the affected customers that it expected to send their information to the IRS by March 16.
What can you expect if you are among the customers whose information is turned over to the IRS? If you didn’t report the cryptocurrency transactions on your tax return, you will likely receive a notice from the IRS alerting you that your tax return doesn’t match the information the IRS has about you. If you agree with the proposed adjustment, you can just pay it, or if you cannot pay it, you can request an installment agreement.
If you do not agree with the proposed adjustment, you can send a response explaining why you disagree. For example, the documentation may not have included your cost basis in the cryptocurrency sold, which would reduce your gain. Or, if the IRS proposed penalties, you may want to demonstrate that you satisfy the reasonable cause exception. It is recommended that you consult with a tax advisor in preparing your response. If you made the same error on later returns, you may wish to file an amended return to correctly report any taxable gains.